AT&T’s capex announcement is still sending ripples through the networking hardware business. Let’s face it, right now it’s a telco bloodbath for equipment providers. As we noted on Friday, many telecom equipment suppliers have missed their quarters and have been forced to guide down. This is based on one thing and one thing only: Pricing pressure in legacy proprietary hardware.
Even before the AT&T announcement, suppliers were already under a lot of pressure, as witnessed by one round of vicious pricing cuts experienced by Ciena (CIEN) in the quarter and the daily rumors of more pricing cuts in markets such as IP routers. You have to ask: How is this going to be good for Cisco? The company reports earnings tomorrow, after the market close. Some analysts predict the company will have to lower its guidance, based on service provider market alone.
“We think Cisco’s revenue guidance this week may be soft, largely due to the Service Provider market,” wrote MKM Managing Director Michael Genovese in a research note.
Cisco may be able to get by in it’s other markets, but the service provider market has been a thorn in Cisco’s side for some time. In its fiscal fourth quarter announced in August, earnings came in at expectations, but the numbers were weighed down by service provider spending and China. Service provider spending was down 9% in that quarter.
The problem goes back to the economics of the carriers. Take a look at AT&T: It just announced that it’s making a $2.5B acquisition. Investors are worried about the dividend. It has piles of debt, and it’s trying to buy DirectTV. Where’s all the money going to come from? The answer is: Out of the capital spending budget (capex) and suppliers’ pockets.
The service providers can afford to take this risk because they see the promise of cheaper technology coming. As white-box and Software Defined Networking (SDN) comes onto the scene, they see a day when they don’t have to pay for proprietary software. AT&T is working on its Domain 2.0 program for next generation technology, and sources tell us that Verizon is active as well. This means one thing and one thing only: Existing, proprietary hardware vendors are under threat.
Cisco is fighting this trend, but it’s probably not going to work out on them in the near-term. Verizon and AT&T want cheaper gear.
(Disclosure: No position in stocks mentioned at the time of writing, and generally avoiding the telecom sector.)